Rising Pump Prices Follow China Refining Losses: Energy Markets

China’s first price increases in 10
months for gasoline and diesel may signal a policy shift to
limit the refining losses that discouraged production in the
world’s biggest energy consumer.

The National Development and Reform Commission, China’s top
economic planner, indicated Feb. 7 it may let retail fuel
tariffs track global crude prices more closely after allowing an
increase of as much as 4 percent. The decision is a sign China
is willing to let retail fuel prices rise further, according to
Goldman Sachs Group Inc.

China Petroleum & Chemical Corp. (600028) and PetroChina Co., the
nation’s biggest refiners, are losing as much as $4 a barrel
under Premier Wen Jiabao’s controls on what consumers pay at the
pump, according to JPMorgan Chase & Co. Inflation in the world’s
fastest-growing major economy slowed to 4.5 percent last month,
from 6.5 percent in July, giving the government more leeway in
lifting fuel prices and encouraging domestic production.

“China will raise domestic fuel prices several more times
this year,” said Gordon Kwan, the head of energy research at
Mirae Asset Securities Ltd. in Hong Kong who forecasts total
increases of 15 percent in 2012, with the next adjustment as
soon as April. “Ensuring domestic fuel supply by restoring fair
profit margins to oil companies will be a politically correct
move,” he said in an e-mail.

Total refining losses in China last year were about 100
billion yuan, Nilesh Banerjee, a Mumbai-based analyst at Goldman
Sachs, said in a Feb. 8 report. Fuel tariffs advanced as much as
550 yuan a ton in 2011, even though China’s fuel-pricing formula
indicated they should have gained 1,500 yuan, the NDRC said in a
statement Feb. 7.

Last week’s increase of 300 yuan a ton reversed a cut by
the same amount on Oct. 9. Prices need to rise a further 500 to
1,000 yuan for oil companies to break even on their crude-
processing operations, according to Banerjee.

“It is encouraging to see the NDRC respond to rising oil
prices, reduce refining losses, and encourage consumption
efficiency,” Banerjee said in the report. It is a “clear
signal of fuel pricing reform from the government,” he said.

Brent oil has risen 12.3 percent since Oct. 9 to $118.93 a
barrel. Dubai crude, an Asian benchmark grade, has climbed 15.8
percent, while Cinta, an Indonesian crude also used as a
benchmark by China, has advanced 13.1 percent.

Faster Increases

Current rules let the NDRC adjust retail fuel when the 22-
day moving average of a basket of Brent, Dubai and Cinta changes
more than 4 percent. That average rose about 4.1 percent since
the last price revision, JPMorgan analysts led by Sophie Tan in
Hong Kong said in a Feb. 8 report.

“In the past, the NDRC delayed hikes because of
inflationary concerns, but with the consumer price index
expected to decline, the hike was quickly implemented when the 4
percent threshold was reached,” Tan said in the report.

China’s inflation rate unexpectedly accelerated to 4.5
percent in January from 4.1 percent the previous month as the
Chinese New Year holiday boosted spending. It may still drop
below 4 percent for the first time in 17 months in February, the
NDRC said Feb. 13.

Inflation Trend

“Inflation is indeed trending lower, which in our view,
provided a sufficient setting for policy makers to raise fuel
prices,” Soozhana Choi, the Singapore-based head of Asian
commodities research at Deutsche Bank AG, said in a Feb. 8
report. “The move is also likely an effort to incentivize
refiners to maintain high runs and ensure ample supplies.”

China faces a shortage of 1.27 million tons of diesel this
year, China National Petroleum Corp., the parent of PetroChina,
said in its annual report on the oil and gas industry Feb. 9.
The shortfall will be higher should a conflict in the Middle
East increase crude costs, CNPC said.

The latest fuel-price boost may do little to lift output in
the short term because supplies are ample, according to JBC
Energy GmbH, a Vienna-based consultant.

“We are skeptical that the higher fuel prices result in a
significant increase in domestic production as refiners already
boosted run rates to record highs at the end of 2011,”
Alexander Poegl, an analyst at JBC Energy, said by e-mail.

Record Run Rates

Average utilization rates at China’s largest refineries
were 87.8 percent as of Dec. 22, near the highest level of the
year, according to Oilchem.net, a Shandong-based industry
website. The rate was 87.6 percent as of Feb. 2. The nation’s
inventories of diesel rose by 800,000 tons to a four-month high
of 8.6 million tons in December.

Sinopec is losing $1 a barrel even after the latest fuel-
price increase, while PetroChina’s margin is as low as minus $4,
Tan said. China processed an average 9 million barrels of crude
a day last year, according to customs data compiled by
Bloomberg.

Planned revisions to the current system to “rationalize”
prices may include shortening the pricing cycle, improving the
execution of changes and revising the crude grades assessed,
according to the NDRC. China may reduce the 4 percent threshold
for global crude-cost changes to 2 percent, and shorten the 22-
day period to 10 days, China Business News reported Feb. 10,
citing an unidentified person.

Diesel Imports

“A shorter cycle for price adjustments, which curbs
hoarding, and better margins for refiners under the new
mechanism will help reduce the chances of fuel shortages on the
domestic market,” said Liao Kaishun, an analyst with C1 Energy,
a Shanghai-based commodity researcher who estimates refiners
lost 113 yuan a ton importing diesel as of Feb. 13.

Previous shortages have boosted imports of oil products and
lifted Asian refining margins. Electricity rationing a year ago
caused factories to switch to diesel-fired generators,
increasing net imports of the fuel to 290,000 tons in December
2010, the highest in more than two years.

Gasoil (PVMPGDM1), or diesel, with 0.5 percent sulfur content cost as
much as $24.17 more than Dubai crude in March 2011 after China
International United Petroleum & Chemical Corp., the nation’s
biggest oil trader, said it would cut diesel exports to conserve
stockpiles. The difference, the so-called crack spread, was the
biggest in 2 1/2 years, according to PVM Associates Ltd., a
London-based oil broker.

The crack spread may narrow to as low as $15 next quarter
as supplies remain sufficient, according to the average forecast
of three analysts surveyed by Bloomberg. It was $17.12
yesterday, compared with $18.68 before the fuel-price increase
was announced, PVM data show. Dubai crude was at $116.22 a
barrel as of Feb. 15.